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What is blockchain? Remington Ong explains

Blockchain is a database that is shared, encrypted, distributed and based on consensus about what is true.

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The blockchain is a global trend, but one that is not widely understood. Yet consider this:

In October 2016, Bank of China and HSBC announced a pilot program for mortgage services in Hong Kong. In November, the Monetary Authority of Singapore began testing the use of digital currencies through a blockchain for interbank settlements. In February, 2017, Hong Kong’s Securities and Futures Commission joined a global consortium of regulators developing standards for blockchain.

Great. So what is blockchain?

Remington Ong, partner at Fenbushi Capital in Shanghai, the first Chinese venture-capital fund focused solely on blockchain, wants to remind you of what happens in today’s pre-blockchain world when money moves around.

You remember this story: in February 2016, the Federal Reserve Bank of New York received money-transfer requests from the central bank of Bangladesh totaling $951 million. The requests came via the Swift network, which is a global messaging system used by banks worldwide for this sort of thing.

It’s routine, and the Fed responded by sending some money to designated banks in the Philippines. It had wired $81 million but paused when someone there noticed a recipient bank’s name had been misspelled. They called Dhaka to confirm. But the Bangladeshis had no record of sending any such requests. Almost a billion dollars had been ordered out of Bangladesh Bank’s coffers – illegally.

Hackers had broken into Bangladesh Bank’s systems and found out the credentials and passwords it used to transfer money. They sent out $951 million’s worth of requests, and then deleted all traces of their activity on the bank’s ledger. Although only $81 million was ultimately transferred to the Philippines, that still makes this one of the top-10 biggest bank heists in history, Ong said.
The perpetrators have yet to be identified or caught, he added.

Speaking at a Finnovasia event in Hong Kong in February, 2017, Ong retold this story because the crime might have been prevented if banks were using blockchain technology to move money.

Ingredients

Blockchain technology creates trust. If banks used blockchain, Bank Bangladesh and the New York Fed could collaborate on money transfers without a central authority such as Swift.

Swift exists because under today’s system, when a bank transfers money, it keeps a ledger of its various accounts, their credits and debits, money in and money out. So does each of its counterparties. But Bank Bangladesh doesn’t let the New York Fed see its books, and vice versa. Swift is useful as a protocol, so instructions are clear, and also as a centralized router for messages. But Bangladesh Bank’s security measures were weaker, and when it got hacked, the rest of the network remained unaware. When New York flagged message errors, there remained confusion as to who was at fault.

The problem, Ong says, is that ledgers at different banks didn’t match, and no one could agree on why. The solution is to create a single ledger for every single bank transaction. That’s the core of blockchain: it is a shared database.

But no bank wants to share its data with another bank. So blockchain operates on encryption, so that users are only permitted access to relevant data. So blockchain is a shared, encrypted database.

But if all of this valuable data is stored on a single ledger, no matter how good the encryption, it’s going to attract hackers like honey draws flies. The solution is to create multiple copies, so that no one point of control can be corrupted. If one bank gets hacked, the ledger will be preserved at other places. Therefore blockchain is a shared, encrypted, distributed database.

But how do you make sure all of these copies are kept in sync, so that they show identical records? The answer has been to create a rule for joining or transacting on a blockchain: your copy must comply 100% with everyone else’s. If there is a discrepancy , who’s right and who’s wrong? That’s decided by the majority. If 50% plus one vote for a particular version of the ledger, then everyone else must automatically conform.

This is probably the most important part of defining blockchain, Ong says. If central banks were using it to move money, the New York Fed and every other member bank’s ledger would show no record of a request for money from Dhaka, and Bank Bangladesh would have to either adjust its ledger or leave the network. Blockchain is a shared, encrypted, distributed, consensus database.

Variations

Blockchain technology originated with banking payments, but it can be applied to all sorts of activity requiring data, Ong says: medical records, music files or records of real-estate deals are among the many potential items that can be recorded and transacted this way.

Some blockchains are decentralized or ‘permissionless’, such as the one used to transfer Bitcoin. Anyone can download Bitcoin software, join the Bitcoin network, and become part of the consensus-voting community.

Other blockchains require permission to join. But even in consortiums of likeminded users, such as Swift for banks, participants still rely on the central utility to establish trust. Swift, banks and governments are exploring blockchain to update these consortiums and establish trust in a more efficient way.

Blockchains might even be used within a single large organization, Ong says. He notes the different incentives and rivalries among a financial group’s investment bankers and traders, versus their compliance and risk managers.

Blockchains can be totally private, or not: Bitcoin transactions are all visible online. Account holders may be anonymous, protected behind a strong password called a ‘private key’, meaning a long string of random characters. These are not unhackable. But they are very, very difficult to break. The bigger threat is how people store their passwords. Writing it on a Post-it Note or emailing it to a friend is a good way to compromise security.

Nor does the consensus system mean no one can ever hack a network. It just creates a high barrier to corruption, because hackers would have to compromise 50% or more of participants’ ledgers.

But so long as consensus remains intact, no one can spend the same money twice.

This is why Bitcoin operates on blockchain networks: as a store of value, it relies on blockchain’s consensus system to guarantee only one version of a digital-money account is recognized.

Blockchain is a database, and like any database – such as the simple numbers on my Excel spreadsheet – it is more valuable when it can perform functions. This is where smart contracts come in: automated instructions on how items on the blockchain, such as Bitcoin – as well as ‘smart’ equities, bonds, syndicated loans, legal contracts, audit reports or anything else – can be treated.

“Blockchain is a distributed trust database,” Ong said. “Smart contracts automate how it works. Combine these two things, and you get a machine that creates trust.”


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